5 Housing Stocks Worth Moving Into in 2011 - 13005 views

BALTIMORE (Stockpickr) -- Housing has been under fire in 2011. The latest data from the S&P/Case-Shiller Index suggests that housing prices are falling again in most major U.S. cities. But lower prices haven’t necessarily helped things – new home sales, an indicator of overall real estate transactions, slid 16.9% last month. That’s the worst rate on record since 1962.

There’s ample reason to be betting against the housing market right now -- but there’s even more reason to buy housing stocks in 2011.

That may sound like a bizarre idea, particularly given the housing data that’s being reported to Wall Street, but those bleak numbers may be somewhat misleading. Right now the U.S. real estate market is more affordable (on a cost-of-capital basis) than it’s been in decades. And that re-adjustment has meant that a large base of Americans qualify for loans right now. Couple that with substantial cash in corporate coffers, and the commercial real estate market is similarly compelling.

Controversial as being a housing bull may be, I’m in good company. Two billionaire fund managers, Bill Ackman and John Paulson, have been making high-profile positive predictions about the housing market right now.

Ackman and Paulson’s opinions about the housing market aren’t just significant because of their career-long success in the markets -- they’re significant because these two made billions by betting against housing in the first place.

With that, here’s a look at five housing and real estate-related stocks that could be worth moving into this year.

D.R. Horton

It’s hard to discuss housing stocks without bringing up homebuilders such as D.R. Horton (DHI). While the latest decreases in new-home sales and prices could pose a major setback for homebuilders such as Horton, the fact remains that this company is leaner, meaner and more adaptable than it was just a few years ago.

Like most of its peers, Horton took the slower operating pace of the last few years as an opportunity to tighten its belt and lean out its operations to a recessionary pace. Part of that process involved significantly reducing home inventories -- a factor that not only reduces risks for the builder’s balance sheet but also helps to reduce aggregate supply of new homes. Remember, these sorts of moves were made across the industry.

Despite the use of new-home sales as an economic indicator, the fact remains that the market for new construction is only partly correlated with the broad real estate market. Because the buyer demographic is so different, and because multi-billion-dollar builders such as Horton can leverage their own operations to help complete sales (much like automakers do), there’s considerable reason to expect improvements in sales numbers this year.

Much of the same can be said for homebuilding peer Lennar (LEN). Like Horton, Lennar benefits from significantly trimmed operating costs. Unlike its competitor, Lennar’s management was slightly more prescient in shifting its business to adapt to the challenges of decreased sales. As Lennar’s sales grew exponentially in the housing boom of the mid-2000s, the firm slowly deleveraged considerably itself without slowing its growth pace.

While the recession was painful for Lennar, the company countered by cutting its overhead costs nearly in half. The company also took an opportunistic approach to the real estate market, funding a division that targets distressed real estate properties for future development. As such, the company is amassing a large portfolio of developable land at cut-rate costs. Right now, Lennar is the best-in-breed builder.

The moves to slash costs and reduce exposure to riskier assets hasn’t gone unnoticed by investors. Already in 2011, building stocks have rallied 8.47% -- more than double the rate of the S&P 500.

One of the most oft-forgotten groups of housing stocks is the home improvement retailers. This group actually has potential to benefit regardless of the change in housing prices. That’s because as inventory sits on the sidelines, homeowners are looking to differentiate their offerings with improvements. Instead, retailers such as Lowe’s (LOW) are more beholden to consumer spending numbers, which are (somewhat) less directly tied to housing prices.

So even as housing prices have languished of late, the uptick in consumer spending numbers has at least meant growth for Lowe’s. Like the homebuilders, home improvement retailers significantly reduced their costs in the past several years as the wealth effect trickled down to reduce spending in their stores. Now, with deeper margins than ever, this stock is worth a second look.

To be sure, Lowe’s is very evenly matched with top competitor Home Depot (HD). That said, a slight operations advantage at Lowe’s, coupled with a more bargain-priced valuation make this the retailer worth focusing on -- at least for now.

Even though housing numbers continue to grab the headlines, they’re hardly the only way to get exposure to the real estate business; another attractive alternative comes from commercial real estate. Commercial and residential real estate have seen similar fates in recent years, but key differences do make exposure to both a good diversifying measure for real estate investors.

One example is in real estate investment trusts, or REITs. Because leasing can have big competitive advantages over ownership for corporations, REITs have emerged as accessible ways to become a landlord. The biggest misconception about these investment vehicles, however, is that they move with the ebb and flow of the real estate market itself. They don’t.

Since most REITs engage their tenants in long-term, triple-net leases (that free the REIT from most risks of market conditions, property tax costs, and maintenance fees), they’re actually excellent, predictable income vehicles. One of the best is Digital Realty Trust (DLR), a REIT that owns datacenter locations in key geographic areas that are used by companies to handle IT needs.

Digital Realty benefits from relatively high barriers to entry, a significant shortage of supply for comparable facilities, and a 4.83% dividend yield at present. Because lease agreements are penned for very long periods of time, DLR doesn’t benefit from a massive rebound in the commercial real estate market, but barring its tenants going out of business, the trust is also incredibly insulated from any downside. REITs are significantly outperforming the broad market in 2011, both in terms of dividends and capital appreciation -- as an industry, these trusts hare up more than 15% since the start of the new year.

Exposure to the housing market doesn’t need to be particularly concentrated. For investors looking for an instantly-diversified basket of real estate sector stocks, an exchange traded fund like the iShares Dow Jones US Real Estate ETF (IYR) may be the most attractive choice. With positions in significant, broad REITs, this fund benefits from a relatively strong 3.41% dividend payout.

And exposure to non-REIT stocks adds more direct capital appreciation as well.

At the time of publication, author had no positions in stocks mentioned.

Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.